Transforming Supply Chain Finance with Blockchain

Small and Medium-sized Enterprises (SMEs) account for more than half of the world’s GDP and two-thirds of all employment. They range in scale and ambition, from fast growing start-ups to stable, medium-sized manufacturing businesses. Despite their importance to the world economy, SMEs often face problems accessing credit when and where they need it. Their banking needs are often more complex than the usual retail banking customer and they don’t offer banks the revenue potential of larger corporations. Add to this their lack of sufficient collateral and poor or non-existent credit histories and it becomes clear why traditional financial institutions have been somewhat reluctant to do business with the sector.

However, the situation seems to be changing. A recent report by Accenture mentioned that banks in UK alone could make more than $11 billion in fees by 2020 through providing value added services to the SME sector. There is now a greater focus on this market by both banks and fintechs. The financiers have started offering tailored services such as invoice and supply chain financing, which take into account the credit ratings of the corporate partners (anchors) in the SME’s supply chain. Not only does this reduce the risk for the financiers but it also gives access to more financing at a lower cost to the SMEs. It benefits the corporate partners as well by eliminating instability caused by SMEs’ inability to access cost effective working capital finance.

Even supply chain financing, though, comes with its own set of challenges. The rate of borrowing for the SME (supplier) or their cost of working capital is dependent on the corporate partner(buyer)’s bank which does not leave a lot of scope for negotiations. The lack of transparency in transactions results in a lack of trust between the parties. This in turn, results in the inability of the buyers to improve cash flows for their entire upstream supply chain by financing the buyer’s tier 2, tier 3 suppliers (i.e their supplier’s suppliers).

To address these issues in a cost effective way, organizations are investigating the use of Blockchain technology for supply chain financing. Blockchain can reduce processing time, eliminate the use of paper and save money, while ensuring transparency, security and trust. Blockchain technology is designed to virtually eliminate the risk of manipulation by participants in the chain. It opens an online market place for the buyer, supplier and financiers and facilitates trade directly between these parties while eliminating the need for intermediaries. A block in the block chain has three key components, a transaction, a transaction record and a system that verifies and stores the transaction. Open source software such as Hyperledger generates and records information about the transaction. Every transaction contains a timestamp, is secured by a cryptologic process and can be verified by all members of the marketplace at any time. This could be useful in securing a variety of processes such as during the exchange of confidential business documents, order confirmations etc.

The raising of invoices by the supplier will be an individual transaction in a block which may also contain the purchase order, bills of lading, proof of the origin, quality or operations performed on a part or instructions for the place and time of a delivery. This information can be stored, exchanged and modified by the buyer without any cost implications and delays. Once the invoice is approved, a smart contract is created which contains the invoice information including payment methods, time-bound discount rates etc. and is attached to both the supplier and buyer wallets for automated transactions on the due date. Smart contracts can be accessed through a web interface.

So How Does This Market Place Work?

Let’s take an example of invoice factoring with Ethereum as the block chain network.

As discussed previously, all concerned parties – buyers, suppliers and financiers are present in the market place. When a buyer accepts an invoice on the blockchain network, a smart contract is created with the terms and conditions (including the payment terms). This invoice or contract will be accessible to all the financiers in the market place, any of which can accept the invoice and offer factoring facility to the supplier. The supplier thus has multiple choices and gets to choose the best offer. As soon as the supplier chooses the best financing option, the title of the invoice is transferred from the supplier to the financier. On the due date of the invoice, the smart contract is executed and the buyer account is debited with the invoice amount while the bank account is credited with the same amount.

With blockchain, financing Tier 2 suppliers becomes feasible as well. Since the financier can see both the contract between the buyer and its main supplier as well as the order placed with the Tier 2 supplier by the main supplier -details of which can be included in the original smart contract, it can verify both legitimacy and source. Even if the bank is not as familiar with the Tier 2 supplier, it can extend financing to the company against the credit of the anchor.

The Way Ahead

There is an enormous interest in this new technology with many already starting to facilitate these types of market places. Mizuho Financial Group is partnering with tech conglomerate Hitachi to develop a blockchain platform for supply chain management. Eight of Europe’s largest banks including Deutsche bank and HSBC formed a joint venture -named the Digital Trade Chain Consortium- this month to launch a blockchain trade platform. In India, IBM is working with Mahindra Finance to build a blockchain-based supply chain finance solution, which would enable all parties involved in the transaction to act on the same shared ledger, with each party updating only their part of the process, ensuring efficiency, consistency, trust and transparency, while safeguarding sensitive information.

The potential benefits are clear-it allows massive simplification of (banking) processes and significantly reduces costs. There are benefits to suppliers and buyers as well—greater control, speed and transparency of the supply chain. Although the technology is still in its infancy, it’s a question of when rather than if that we see more companies jumping on to the blockchain bandwagon to improve the efficiency of their supply chains.

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About the Author

Saurabha Gupta,
Manager - Product Business

Saurabha Gupta is a product manager for the corporate internet banking and liquidity management solutions at Nucleus Software. With 12 years of experience in the IT industry, Saurabha is chiefly focused on helping corporate banks leverage transformative technologies such as Blockchain and Artificial Intelligence to drive business results. Prior to joining Nucleus in 2008, Saurabha worked as a software engineer at Patni Computer Systems.

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About Nucleus

At Nucleus Software we are committed to providing efficient, modern yet proven software solutions for the global Banking and Financial Service industry. We have been pioneers in developing Retail Banking Software, Corporate Banking Solutions, Transaction Banking, Cash Management and Internet Banking Software since 1986. Our success spreads across more than 50 countries, and we serve our customers globally through our direct and partner operations across US, Europe, Asia-Pacific, Africa and the Middle East.
We are known for our world-class expertise and innovation in lending and transaction banking technology. Our two flagship products, built on the latest technology are: FinnOne™ and FinnAxia™.